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February 26, 2013

PIMCO’s El-Erian: 3 Reasons for Stock Market Sustainability

Sequester deadline will pass, followed by a ‘clumsy’ compromise, bond chief writes

Mohamed El-Erian, CEO of PIMCO. (Photo: AP)

PIMCO chief Mohamed El-Erian points to three hypotheses that, week in and week out, "invigorate and sustain the stock market rally." The three are valid, he notes, yet their longer-term implications may be far more complex than most investors fully appreciate.

“Equity markets believe in the ‘Fed put,’ or the view that the Federal Reserve will increase its monetary policy stimulus in response to any (and all) meaningful decline in risk assets,” he writes in a blog post on Yahoo! Finance.

Second, market participants also “have reason to believe that the steadfast focus of the Fed forces other central banks around the world into more accommodating monetary policy.”

Lastly, then there is the "kick the can" hypothesis, seen lately, which is the view that even unusually dysfunctional political systems, be they European or in America, repeatedly find ways to avoid outcomes that would be really disruptive to markets. El-Erian predicts that, as with the fiscal cliff, the sequester deadline will pass, followed by what he calls a “clumsy” compromise and a continuing resolution.

He then considers each of the three.

The longer the Fed maintains its “unusual policy activism,” the higher the costs and risks. This reality was “vividly illustrated” in the minutes of the last Fed policy meetings released last week, he notes, with several officials referring to the rising probability of both direct and indirect damage.

“As I argued last week, this does not mean that the Fed will abandon any time soon its current policy stance. It won’t. But it does mean that the overall impact on the economy – and, consequentially, companies’ top line revenue growth and their ability to contain non-wage costs – is indeed uncertain.”

Politics adds to sustainability concerns, he continues.

“Citizens are increasingly frustrated with the behavior of bickering and dithering politicians. The result is a growing wave of popular dissatisfaction that undermines the traditional political system, but without offering a durable alternative. This is apparent in a growing number of European countries, including last week’s shock government resignation in Bulgaria.”

For the rally in equity markets to continue, he concludes somewhat obviously, the current phase of “'assisted growth,' as anemic as the outcome is, needs to give way to genuine growth. And the latter depends on the engagement of healthy balance sheets around the world.”